Tuesday, February 8, 2011

CalPERS Accuses Lehman of Fraud

The nation's largest public pension fund accused Lehman Bros. Holdings Inc., its former top executives and numerous bond underwriters of fraud and making materially false statements about losses from mortgage-backed securities during the financial crisis of 2007 and 2008.

The claims are part of a lawsuit that the California Public Employees' Retirement System, which oversees a pension fund now valued at $229 billion, filed late Monday in U.S. District Court in San Francisco.

While the lawsuit did not specify damages, it noted that CalPERS owned 3.9 million shares of Lehman common stock and about $700 million worth of Lehman bonds at the time that Lehman filed for bankruptcy protection in September 2008.

Lehman filed its bankruptcy, the largest inU.S. history, in September 2008, four days after saying that it would report a third-quarter loss of $3.9 billion and write down the value of its subprime mortgage securities and other assets by $7.8 billion.

The suit alleged that Lehman, under the direction of Chief Executive Richard S. Fuld Jr., "dramatically" borrowed to fund its real estate investment activities from 2004 to 2007, engaging in ever-riskier activity that was not divulged to investors.

CalPERS also named Fuld as a defendant, along with Citigroup Global Markets Inc., Wells Fargo Securities and Mellon Financial Markets.

A lawyer for Lehman could not be reached.

The action against Lehman is the second by CalPERS against major Wall Street players involved in the selling of mortgage-backed securities.

In July 2009, the pension fund sued the three largest financial rating firms — Moody's Investors Service Inc., Standard & Poor's and Fitch Inc. The suit faulted the rating companies for giving coveted top grades to bonds that suffered huge losses from the meltdown of the market for subprime mortgage securities.

The largest U.S. public pension fund accused former top executives of Lehman Brothers (LEHMQ), nine former directors, and several of its bond underwriters of making false statements about Lehman's financial condition in the months leading up to its September 2008 bankruptcy.

The California Public Employees' Retirement System, which manages $228 billion of pension assets, made the allegations in a lawsuit filed in San Francisco federal court late Monday.

Calpers experienced losses in its investments in Lehman stock and bonds between June 2007 and September 2008, allegedly because of false and misleading statements made by Lehman's executives about the firm's exposures to mortgages, its valuations of mortgage and other loan holdings, its leverage, and its use of quarter-end accounting gimmicks that masked its true financial condition.

The suit doesn't quantify damages, but notes Calpers held $700 million worth of Lehman bonds covered in the lawsuit and another 3.9 million shares of Lehman at the time of the bankruptcy.

Calpers funds dropped $100 billion in value between September 2008 and March 2009 to $160 billion as a result of the financial crisis, according to a spokesman, who declined to comment further on the lawsuit.

The pension fund has since recovered most of that loss, but it is still targeting those it sees as having a big hand in the crisis. The Lehman suit is its fourth pending. The others include a shareholder suit against Bank of America Corp. (BAC) for its acquisition of Merrill Lynch, a suit against credit ratings agencies over losses in allegedly inaccurately rated structured investments, and a suit against Bank of America's Countrywide Financial.

A spokeswoman for Lehman's bankruptcy estate wouldn't comment. A lawyer for former Lehman Chief Executive Richard Fuld, who is named as a defendant in the suit, couldn't immediately be reached.

Calpers named Fuld as well as former Lehman Chief Financial Officers Christopher O'Meara and Erin Callan and nine Lehman directors along with 33 other firms that underwrote some of Lehman's bond offerings as defendants, alleging they failed to disclose Lehman's losses and exposures to subprime and Alt-A lending and the true value of the company's mortgage-related assets.

I'm not sure where CalPERS is going with this lawsuit but if they're able to find out exactly what Dick Fuld and Chris O'Meara knew prior to the storm, then it's worth the cost. I also think CalPERS is sending a clear message to bankers: if you screw around again, we will come after you with everything we got.

The number of "high-value" tips on fraud and other violations of securities law numbered about two dozen a year before the law. But since July, the agency has sometimes been receiving one or two a day, Thomas Sporkin, chief of the SEC's Office of Market Intelligence, told the SEC Speaks event sponsored by the Practising Law Institute.

Whistleblowers who provide "original information" about large frauds could net as much as 30 percent of the penalties and recovered funds collected by the SEC under the Dodd-Frank act.

"Sometimes the whistleblower is from within the corporation, sometimes it's from a competitor, sometimes it's from a counterparty, sometimes it's even from a jilted spouse," Sporkin said.

He also said the tips are now often submitted by a lawyer on behalf of a whistleblower and are of good enough quality to allow the agency to begin following up quickly.

BIG BANK PAY PROPOSAL: Federal regulators have proposed making top executives at large financial firms wait at least three years to be paid half or more of their annual bonuses.

REINING IN RISK: The move is designed to cut down on risky financial practices and tie bonuses to executives' performance over a longer time period. Pay at Wall Street banks tied to incentives was seen as fueling the financial crisis.

FDIC MOVES: The Federal Deposit Insurance Corp. also moved Monday to make bigger banks pay a greater portion of fees to insure all U.S. banks.

Claudia Allen, an attorney and chairwoman of Chicago law firm's Neal Gerber Eisenberg's corporate governance practice group, said determining the cut off point between the two extremes is the "holy grail" question of corporate governance today.

"The general question is: Do these regulations create unnecessary economic costs?" Allen said. "Are they pro-growth? Are they excessive or just right? There has been a lot of regulatory interest in how to make sure that boards and executives are taking prudent risk, not excessive risks."

The issue became even more pronounced after taxpayers stepped in more than two years ago to bail out financial institutions burdened by debts after a period of institutionalized risk-taking.

Allen said the tough part is balancing this idea of containing excessive risk with a basic societal fact that "you have to take some prudent risks to run a business."

She said the "question is are the regulators doing it in a way that is prudent, or are we creating other societal costs?"

I wonder if Ms. Allen has factored in the "societal costs" of millions of unemployed workers who lost their job following the financial crisis. For me, it's all about having skin in the game and aligning interests with shareholders. Warren Buffett was right when he said you got to punish failed bankers:

“If I was running things, if a bank had to go to the government for help, the C.E.O. and his wife would forfeit all their net worth,” he said. “And that would apply to any C.E.O. that had been there in the previous two years.”

Alignment of interests is why I endorse CalPERS' latest lawsuit. And it's not just CalPERS. Increasingly, pension funds are suing banks and companies over a host of issues ranging from investment losses to overcharging pension plans on currency trades. In all likelihood, nothing will come out of these lawsuits, but the message to the financial and corporate elite is clear: if you defraud investors or cause serious losses through negligence and malfeasance, pensions will come after you.

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